The biggest risk a business faces is having bad management. That’s according to Warren Buffett in his latest shareholder meeting – writes the Undercover Fund Manager

 

I agree. Assessing company management is one of the most important jobs an investor faces, but it’s far from easy and is more an art than a science.

Buffett’s business partner, Charlie Munger, famously says, “All I want to know is where I’m going to die, so I’ll never go there”. I tend to approach the challenge of assessing company management in a similar way.

Below, I outline (in no particular order) a series of red flags that serve as warning signals for me. Some of these are very common and won’t necessarily put me off from investing in a company, but a combination would be a potential cause for concern.

 

Red flags to watch out for

 

  • Excessive focus on factors outside of management’s control, such as quarterly profit and share price, as opposed to things like customer and employee satisfaction.
  • Excessive optimism, combined with a tendency to over-promise and under-deliver. Words not backed up with actions.
  • Excessive focus on growth with little mention of returns.
  • Evasive, often failing to answer the question asked.
  • Highly promotional – more interest in selling a story than explaining the business.
  • Favour jargon and obfuscation, seemingly incapable of explaining things simply.
  • A willingness to issue short-, mid- and long-term ‘guidance’, combined with an eagerness to cut costs to meet said guidance.
  • Poor attention to detail, evidenced by ‘woolly’ statements not backed up with data, a lack of suitable key performance indicators, etc.
  • Lack of clarity/muddled thinking in verbal and written communications.
  • Lack of candour combined with an unwillingness to admit mistakes.
  • Unwillingness to discuss areas for improvement, even when questioned.
  • Regularly blame poor results on external circumstances, eg, weather.
  • A short-term business outlook.
  • A poor understanding of where the company’s competitive advantages lie.
  • A lack of focus, evidenced by questionable diversification efforts or unwillingness to consider asset disposals, for example.
  • A lack of independent thought.
  • Hiding or withholding important information.
  • Liberal use of exceptional items, regular accounting changes and other signs of financial jiggery, combined with a focus on adjusted metrics (eg, adjusted EBITDA).
  • Aggressive accounting relative to peers.
  • Constant restructuring and changes in business strategy.
  • Constantly moving targets, changing divisional reporting structures, etc, making it hard to track progress.
  • Excessive time spent on investor relations.
  • CEO flashy, arrogant, over-confident and/or a control freak (eg, not letting CFO get a word in edgeways).
  • Defensive manner, especially in response to difficult questions.
  • Complacent, constantly downplaying genuine risks and threats to the business.
  • Excessive reliance on equity issuance to fund growth projects with questionable returns.
  • Excessive remuneration, inappropriately structured (eg, one-year share price/profit performance) combined with low director share ownership.
  • Excessive use of debt/leverage.

 

 





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